Falling rupee adds fuel to India's crisis

Last updated: 25 September, 2011

DHNS

Investors’ flight to dollar, due to Europe’s financial crisis, has sharply depreciated the Indian rupee. It is unclear where it will stop, writes Suresh Nandi

The rupee is under attack. Indian Rupee, last Friday, nearly breached the Rs 50 per dollar mark and closed at 49.90 - its weakest since May 14, 2009. Since July 27, when the Rupee was at Rs 43.85 a dollar, it has lost 10.21 per cent or Rs 6.05 against dollar due to sustained dollar demand from banks and importers in view of the firm dollar sentiment in the New York market.

Most forex dealers In Mumbai during the week predicted that in the absence of any positive news, the rupee could soon touch the 50 mark against the dollar and could also breach the all-time low of 52.17 within the next three months.

From an investors’ perspective, the movement of rupee may not matter much as only a few can figure out that unlike Sensex, the rupee going up is not positive news, but on the contrary, it actually means rupee is becoming weaker. Many wrongly think that if rupee goes up it is something good for them not realising when the Indian currency depreciates against any foreign currency it has many negative impacts from the economic point of view.

Why is rupee falling?

Historically, the Indian Rupee has been depreciating roughly in line with the fall in its Purchasing Power Parity (PPP) since the early 1980s. While the PPP was 15 around 1982, the actual exchange rate was Rs 9.30 per US Dollar. It is the inflation that negatively impacts PPP and pushes a currency down. But the present spike was rather sharp on the back of debt default concern in the euro zone and after the downgrading of two largest French banks, besides Lloyds Insurance withdrawing its deposits from European banks have led to euro losing its value against dollar. As large banks, investors and financial institutions started selling euro and bought dollar, the latter appreciated against all major currencies including rupee.

From the start of this financial year, the Indian Rupee has depreciated by 6.86 per cent and it was the worst performer among major Asian currencies losing nearly 12 per cent of its value since touching its 2011 high of 43.85 against the dollar on July 27. The rupee would have fallen further but for the market intervention by the Reserve Bank of India.

One school of thought is that unlike its Asian peers, the RBI could not have intervened in a big way in the currency markets with its fragile holding of foreign exchange reserves. Avers Jamal Mecklai of Mecklai Financial Services: “The RBI is going to intervene only if it is meaningful. The biggest issue is of course the uncertainty with the Euro. Nobody believes that the Euro problem is solved.”

With FII flows too coming down, the pressure got accentuated and rupee nearly breached the 50-mark. Moreover, the global volatilities are bound to have an impact in the entire Asian markets, including, India, pointed out Birla Sun Life Mutual Fund CEO A Balasubramanian. “The rupee weakness is basically due to the European crisis and has nothing to do with the domestic economy,” added HDFC Bank’s head of forex operations.

Gainers of Rupee depreciation

When a currency depreciates, the exporters rejoice because they get more of the local currency for every unit of foreign currency though the quantum of trade remains unchanged. But this time, many exporters were caught off guard. For one, there is little dollar supply in the market as most exporters seem to have covered themselves in the Rs 45-46 range. “Sudden changes in the position of the rupee do not really matter much.

Exporters these days resort to hedging against such risks (of volatility),” said the Federation of India Export Organisations (FIEO) chief Ramu Deora. Besides, the buyers overseas also renegotiate and push rates down.

The depreciating rupee will be positive for the Indian IT sector who generate more than 80-90 per cent of their $70 billion revenue from the overseas markets and this kind of appreciation in foreign currency will enhance their actual realisation of revenue in dollar terms. Every one per cent change in rupee-dollar has a 40 basis points impact on the margins on the net profit numbers of IT services companies like TCS, Infosys, HCL to mention a few. However, IDBI Bank chairman R M Malla was of the viewed that “exporters gain only in the short term and after that overseas buyers seek price adjustment.”

Says Bank of Baroda GCC Operations CEO Ashok K Gupta: “Expat Indians in the UAE usually accumulate dirham with an eye on the exchange rates and remit funds as soon as the rupee falls.” With the dirham now fetching over Rs 13.50 as against Rs 1130 in July 2011, remittances from the UAE between July and September 2011 jumped 30 per cent compared to the preceding quarter. India was the world’s largest remittance recipient in 2010 with $55 billion transferred to the country by expatriates.

Negative impact

When a currency loses its value it creates many problems for the economy. It leads to high inflation, as India imports around 70 per cent of its crude oil requirement and the government will have to pay more for it in rupee terms. Due to the control on oil prices, the government may not easily pass the increased prices to the consumers. Further, this higher import bill will lead to rise in fiscal deficit for the government and will push the inflation, which is already hovering around the double-digit mark.

On the other hand, India Inc will also have to pay more in rupee terms for procuring their raw materials, despite drop in global commodity prices, only because of a depreciating rupee against dollar. Already, oil companies cited the fall in the rupee value to the dollar to increase petrol prices recently. For oil marketing companies with every fall in the rupee, the under-recovery on account of petroleum products goes up by Rs 9,500 crore per year on the price-controlled items, said an HPCL official.

Just like oil, all products and commodities are more expensive to import now. Corporates, who have foreign currency loans on their books, also take a view that despite a depreciating rupee, keeping the benign interest rates in developed markets would be lot better to hold on to foreign currency debt as one gets 0-2 per cent interest on dollar debt compared with 12-14 per cent on rupee debt.

Individually, traveling abroad becomes more expensive as travel cost can go up by at least 10 per cent. Students studying abroad too will be hit as more rupee will go out to pay for the courses and stay.

Depreciation of rupee also affects the money flow in the Indian stock markets. FIIs, the main investors in the Indian equity markets, also start withdrawing their investments from the markets fearing loss of value. In terms of portfolios, if you hold stocks in oil and gas, infrastructure, fertiliser or tyre business, your returns will take a hit as the shares of these companies will fall when the rupee falls as they procure their raw materials from abroad. On the other hand stocks of Information Technology (IT) companies and export-oriented units should do better.